This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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On March 30, the U.S. Advisory Commission on Electronic Commerce (ACEC) sent a majority report to Congress, a 43-page document that Chair James Gilmore, governor of Virginia, called a "comprehensive set of good ideas."

The commission was created by the Internet Tax Freedom Act of 1998, which placed a three-year moratorium on new or discriminatory taxes on Internet commerce. It created a 19-member commission, appointed by congressional leaders and including three representatives of the Clinton administration.

Dean Andal, currently chair of the California Board of Equalization, was appointed to the panel. The former Assembly member from Stockton was instrumental in gaining language in the report dealing with nexus (physical presence) requirements of remote sellers. His motion during the telephone conference call session to send the report to Congress was adopted on a 10-8 vote, three shy of a two-thirds majority needed under the law for official ACEC recommendations. (One member, a supporter of the final product, was unable to participate in the final telephone meeting, which followed four face-to-face sessions over 10 months, in Virginia, New York, California and Texas.)

There was general agreement on a few issues that included a continued ban on taxation of Internet access and repeal of the 3 percent federal excise tax on communications service, which had been enacted to finance the Spanish-American War. Otherwise, the news media reported that the panel was hopelessly deadlocked on major issues, deeply divided among what reporters called the no-taxers and the pro-taxers, and that true consensus was not attainable.

The report embodies a proposal generated by six corporate leaders serving on the commission, details of which were reported in the February Cal-Tax Digest. It calls for a five-year extension of the moratorium, which expires next year, and encourages a simplified sales tax system. The no-taxers did not get a permanent ban on the taxation of e-commerce; the pro-taxers did not get a lifting of the moratorium.

Mr. Andal discusses the commission's work in the following April 6 interview:

Cal-Tax: Some of the media portrayed the commission as divided between no-taxers and pro-taxers, and with you on the no-taxers side. Is that really a fair characterization of the division on the commission?

Mr. Andal: There definitely was a split and there was a majority (not two-thirds) opinion, and some of the recommendations of the majority were indeed less taxes. The proposal to abolish the 3 percent excise tax on telecommunications is clearly a recommendation to cut taxes over the status quo, and the minority voted against that when they voted against the final report. Some of the other recommendations could be portrayed in some states as the status quo. For instance, the part that relates to the nexus standard and the safe harbors from physical presence in nexus is the status quo in California.

Cal-Tax: What is the significance of the nexus standard adopted in California? What does it mean to have it adopted in the commission report?

Dean Andal, chair of the California Board of Equalization, served on the U.S. Advisory Commission on Electronic Commerce.

Mr. Andal: The problem we have with California in some cases but more so with some other states is when a state can force an out-of-state company to collect sales taxes for them. The Quill decision, which is a U. S. Supreme Court decision, says that to do that you have to have physical presence. And every state has a different view of what physical presence is and the courts have never adopted a definition of physical presence. So what this does in very specific terms is apply a uniform jurisdictional standard that says physical presence is not these nine things. For instance one of them is a web page; the other is if you use an Internet service provider, that is not, in our view, physical presence and not nexus. And so, under those nine provisions, you are not allowed to force an out-of-state company to collect your sales taxes for you. The interesting thing is that California has already done so many of those things because we have been working on this for the last five years. But many, many other states do not, subjecting California's companies to a lot of overreaching by other states. As a Californian and as somebody who lives exactly an hour and a half from the Silicon Valley, I am very anxious to come up with a standard so that our companies, when they don't have physical presence in these other states, aren't forced to collect other states' sales taxes for them. That will help the Internet prosper because there won't be a lot of litigation in the courts. Congress would decide once and for all what is and what isn't nexus, and that's what we are asking them to do. And then I would argue that that is not a tax cut; that it is simplification because I don't believe that states, when they assert the opposite, are right under current law.

Then the third, most significant piece of our report is digital transfer and what happens on those things. In California, digital transfer goods, such as downloading music off the Internet, or a lawyer's brief, or software that is digitally transferred, are not taxable anyway. As long it doesn't come in physical form it is exempt because in California our sales tax is on the sale of tangible personal property.

So that part of it is the status quo in California, and we are just making that clear in federal law, we hope. But we also added digital equipment and there are very few of these. We think that if you can easily transfer something over the Internet and it would be tax exempt then you should also exempt the digital equivalent. That would effect a very narrow subset of products; perhaps books, videos, music CDs, that sort of thing.

Cal-Tax: What message is the commission sending Congress and the nation about actually taxing e-commerce?

Mr. Andal: There are two messages that come out of this report. First, it is not a good idea to lard on a whole new set of taxes on this great new technological revolution. Government revenue is fine the way it is. We don't particularly need more revenue and there could be a harmful effect on the growth of this Internet revolution if you do apply more tax obligations, either in collection or in additional tax.

The second thing it says is this: You can't tax it anyway because it is not politically and technically feasible. You have a young couple right out of college with a great idea. They want to go on the Internet, put up a website and sell to whoever around the world. Under the minority view on the commission, they would have to collect taxes in 46 different states. They would have to comply with 7,000 sales tax rates and 38,000 tax rate areas, and that doesn't even get to the question of what is taxable and not taxable or what is the tax base in each state. For instance, New Jersey doesn't tax clothing; California does. We don't tax food; New Jersey does. And there are all those differences among the states, so can you imagine that young couple trying to sell products on the Internet, complying with all that complexity? The answer is they could not; it wouldn't work and, of course, that is what we are saying in this report. If you want to simplify, have one rate, have one unit for a base, have one set of forms, and then we'll talk turkey about whether or not it is a good idea to apply tax increases in the future.

Cal-Tax: So you don't give them much of a chance to come up with a simplified system, with uniformity of base, even if they would agree to a rate?

Mr. Andal: I don't even think they can do that.

Cal-Tax: What is it that stands in the way of a simplified, uniform sales tax system? Why wouldn't it work in California?

Mr. Andal: First of all, the coalition that voted for the final report - it was approved on an 11-8 vote - came to the same conclusion that there shouldn't be taxes on the Internet and that's the report we are sending to Congress. But within that coalition, that majority coalition, there are two subsets. There are those who don't believe even if it could be done that it would be a good idea, and that's the camp I'm in. I don't want to force out-of-state sellers without physical presence to collect tax. The other subset said we're not against that and most of the business executives fell in this category: we're not against the idea that tax should be collected, we just don't think it is fair for you to do that before you simplify. So both of us lined up under the proposition, and we called the pro-taxers' bet. If the states and cities think they can simplify, more power to them, and that would lead them perhaps in the future to the ability to collect. I don't think they can do it. I don't think in California, for instance, you can get Modoc and San Francisco to agree on a tax rate. And, you need a two-thirds vote in the Legislature, how likely do you think it is that Republican legislators would vote for tax increases? It won't happen.

Look at it this way: In San Francisco you have the highest sales tax rate permitted by state law, and San Francisco residents, as liberal as they are, would probably like to raise it even further, and the only limitation on them right now is the state Legislature that hasn't allowed them to do that. (State Senate leader) John Burton has never met a tax he didn't like, but if he wanted to lower that rate, so that they could establish a uniform rate, which is the first step of simplification, he would have to face the wrath of his liberal constituents who do not want to cut that tax rate and would not want to give up the government spending that comes from it. Go up to very conservative Modoc County. They don't want to raise their tax rate and they have no interest in more government spending; they probably don't like the existing level of spending, and they don't like the tax. Their legislators are always conservative, and so if they wanted to raise the tax rate to come to a uniform rate, they would have to face the wrath of the conservative voters of Modoc County. And then on top of that, you would need a two-thirds vote of those legislators. So, on arguably the very easiest piece of simplification, I think it is politically impossible in our state to achieve that, much less the other 45 states that have sales tax.

Cal-Tax: Yet some have written that a positive byproduct of this whole debate would be badly needed simplicity in how sales taxes are applied around the country.

Mr. Andal: Say you don't agree with me that simplification is politically impossible. If you don't agree, what we are telling you is to prove it. And if they did simplify, and by the way, what simplification means is also spelled out in our report, so it is not some arbitrary standard that they could easily satisfy. If you can satisfy that, your argument is going to be a lot stronger to overturn Quill and collect from other states. But the states have been promising that for 25 years and they haven't done anything to simplify. So what I am saying is go do it, and then come back and we'll talk. Anyway, we have called their bet and I think that is what will be attractive to Congress, because Congress wants a break in this logjam with the states constantly seeking more tax increase authority and at the same time making their systems more and more complex for people to comply with.

Cal-Tax: Are there national groups representing cities currently working on this?

Mr. Andal: Well, they say they are, and they have lots of meetings and lots of forums at taxpayer expense, usually in vacation resorts around America, and they include the National Association of Counties, League of Cities, the national association of cities, National Governors' Association, National Conference of Commissioners on Uniform State Law, the Multistate Tax Commission, the Federation of Tax Administrators. And they all have one common theme. They say they want to engage in simplification efforts, but what they really want to do is raise taxes. Their objective is to overturn Quill and force out-of-state sellers, regardless of physical presence, to collect sales taxes for them. They mask it, in my view, in a simplification drive. But now that simplification has been clearly defined by this commission, they have something they can work on, and if they don't work on it, there is going to be a lot of skepticism of giving them more power to tax. I think we have achieved a great deal just by doing that.

Cal-Tax: Do you think the nexus issue is the real reason that you couldn't get two-thirds of the commission to support the report?

Mr. Andal: No. I think the bottom line for the state and local governmental officials and the Clinton administration, which is basically that group; the eight who voted no were the three Clinton administration officials, two governors (Mike Leavitt of Utah and Gary Locke of Washington), one county supervisor, Delna Jones of Oregon, Mayor Ron Kirk of Dallas, and Gene LeBrun, president of the National Conference of Commissioners on Uniform State Law. Everybody else voted for it. So these are the folks that want to raise your taxes. That's their primary objective, and the objective of the associations they represent. And I think they have been laid bare. All mischief aside, in the end they really didn't want to compromise; they wanted to raise taxes. Otherwise, we would have found common ground with them.

Cal-Tax: When this goes before Congress, will it be in the form of legislation?

Mr. Andal: The portion I am most concerned with; in fact, I authored it, is the nexus standard. My proposal was adopted in the fall, and it is now part of the committee's report. That proposal will be pulled out of the commission report separately and will be introduced in the Senate. Senator Judd Gregg of New Hampshire and Senator Herbert Kohl of Wisconsin (a Republican and a Democrat) are going to be introducing the bill that contains the commission-adopted nexus standard. So we have authors for the bill and the debate will begin.

Cal-Tax: What about the legislation to extend the moratorium?

Mr. Andal: There is a lot of focus on the extension of the moratorium, but that is probably the least important and the least consequential part of what we are doing, and that is why everybody is for it. The moratorium has never been on sales taxes - that is a common misnomer. The moratorium is on new taxes, and what was mostly envisioned were local taxes. The city of Tacoma (Washington) and the city of San Bernardino (California), to use two examples, wanted to apply utility taxes to Internet traffic and they themselves withdrew that proposal. To stop that kind of mischief at the local level, there was a moratorium placed on new taxes. The sales tax is over 100 years old; it is not new, it was never a part of the moratorium. No one is calling for new taxes on Internet access, and it is really, in my view, meaningless. I don't think very many localities will do that anyway, and so you can count on Congress to do the meaningless.

Cal-Tax: So you're sure Congress will pass an extended moratorium which would otherwise expire late next year?

Mr. Andal: There's little doubt that they will do that. Now there is something at stake there and that is there are fewer than 10 states that already had such new taxes and they were grandfathered in by the Internet Tax Freedom Act. And so when the extension effort goes on, there will be a debate over whether to take away that grandfather clause so that all the states have a moratorium, not just some. I support that.

Cal-Tax: California has its own Internet Tax Freedom Act, which also has a three-year moratorium. Is it important to extend the law in California?

Mr. Andal: The California Internet Tax Freedom Act deals with a broader range of issues than the federal version, including application to cable television, and I think it has been a great service to California that we had that. I think there should be an effort after Congress is finished. Obviously, there is no reason for a state law that does the same thing as the federal extension, but if there are things left out, I think the California Legislature should follow up and extend its own Internet Tax Freedom Act. One of the nice things about this argument is that, with the exception of a handful of very liberal legislators, there has been really a bipartisan consensus in California. Governor Gray Davis, for instance, has been one of four governors across the country who have really stood up for the proposition that there shouldn't be any new tax obligations on the Internet. The four that come to mind are Governor Gilmore of Virginia, our commission chairman, who has been a great chairman, Governor George Pataki of New York, Governor Paul Cellucci of Massachusetts and Governor Davis, who has been really pretty straightforward about his opposition to new Internet taxes. So this is really, for California, not a big scrape. There really hasn't been that big of a controversy between the Democrats and Republicans on what to do. The scrape is really between high-tech states and small rural states. That is where the battle will go in Congress; that is why you see New York, Massachusetts and Virginia lining up with California and you see most of the opposition coming from places like South Dakota and Utah.

We gain so much from the Internet. We gain tax revenue from the Internet; that's why our income tax receipts and sales tax receipts from traditional sources are at all-time highs. California hit historical highs last year in both taxes.

Cal-Tax: Didn't we have a nearly 9 percent increase in sales tax revenue last year?

Mr. Andal: Yes, and something like 17 percent in bank and corporation income tax, so we realize in California what a boon the Internet is. Unfortunately, some of these other states don't benefit so much on that side and so they are more interested in figuring out a way to tax the Internet.

Cal-Tax: Isn't California collecting most of the sales and use tax from Internet transactions?

Mr. Andal: Right. Fifty percent of all Internet transactions are two products: stock sales and airplane tickets. They aren't taxable, so we don't lose anything. Of the other 50 percent, 80 percent is business-to-business, and since we already audit most businesses in California, we pick up the use tax if it is not reported. And then, if somebody buys a car or a plane or a boat, they have to register it and we force them to pay tax on that. So we are really talking about small consumer items, such as a shirt from L.L. Bean or a book from Amazon.com. The reason that there is not an unlevel playing field, which the liberals' secondary argument other than revenue loss, is when you buy a book at Barnes & Noble in California, you pay sales tax. You buy the same book from Amazon.com, they will not charge you sales tax and they are not required to because they don't have physical presence in California, but they do charge you a shipping charge. The shipping charge costs you more than if you had just gone down to Barnes & Noble and paid the sales tax, so I don't believe there is an unlevel playing field at all. The complainers in this debate are small bookstores for whom I have little empathy. I am a big book reader, and I love going to bookstores. I like to read and I buy a lot of books every year. I remember the days when my only choice was a small bookstore and I don't have the romantic notion that some do of those little bookstores. I remember poor selection, poor service, couldn't get a cup of coffee - those are the things I remember, and the real threat to those little bookstores is the Barnes & Nobles of the world that provide you vast selection in one place. They provide you much more customer service than a traditional bookstore, and you can get a cup of coffee. The reason people go on the Internet rather than the local Barnes & Noble is basically convenience, not tax advantage. So, you can tell I have very little empathy for these small bookstore owners and I think they are going to have to compete and offer the customer more. Whether there is an Internet or whatever our tax policy is will not make much difference.

Cal-Tax: Some people say the technology is already available to collect taxes without being a burden on retailers, which might satisfy Quill, but isn't there a privacy issue?

Mr. Andal: The technology does exist so half of that statement is correct. There is no technological reason why you couldn't force collection of tax on all Internet transactions. The question is: at what price, what burden and what privacy loss? And there would be an enormous burden, as I have already pointed out, in complying with all those laws. The computer can tell you what the rate was, but you still would have to fill out all those tax returns. That's no great joy, and then the real thing is that to tax Internet transactions completely the currency of the Internet is the credit card. That's how you buy and sell items on the Internet. And so the point of collection is most obvious: the credit card companies, the banks, the others who issue credit cards, and they would be forced then to collect tax on all the transactions. This is what is called the so-called "trusted third party" approach. The trusted third party would be the bank or credit card company. The problem with that is, go the next step, the state governments would not trust the trusted third party, just like they don't trust individual taxpayers now and they insist on auditing to ensure that they got what they wanted. And so they wouldn't trust the trusted third party, and they would insist on auditing the banks, which leads you to a real Orwellian situation. Right now we don't know what individual California consumers' spending habits are; we have no interest in it when we are collecting sales tax because it is irrelevant. But that is exactly what we would be auditing at that point. We would send auditors to the banks and the credit card companies to audit each credit card account to make sure that the tax had been paid, which means that the state government would have access to the spending habits and buying habits of ordinary Californians. That would be done over my dead body, and I don't think anybody in America - liberal , conservative, Democrat or Republican - is really going to want to take that step. I think that is really an outrageous violation of our privacy rights, and I don't think even those who propose the trusted third-party approach have gone far enough in their thinking to address that problem. I don't think they even recognize it.

Cal-Tax: Can you predict what is going to happen in Washington?

Mr. Andal: I can give you some predictions. I think the excise tax reduction will pass and be signed into law. Richard Gephardt has already indicated that he supports it so there is indication that there will be a bipartisan support for that this year. So I think that will happen. The extension of the moratorium will happen, again, because it is relatively meaningless.

One way or the other it will get worked out and whatever it takes to get through Congress will pass. I don't think that will hold anything up. And then the real fight will be over the nexus standard that I have been working on, and I think that is even odds. I think there will be tremendous support for it, and it may take more than this year. It might be something that is formally brought up for a vote next year. Then there is the digitally transferred goods and services piece, and I don't know how to predict that.

Cal-Tax: Is that going to be separate legislation as well?

Mr. Andal: These issues will be pieced out. There won't be one comprehensive bill.

Cal-Tax: Because this is a majority-vote report and not a two-thirds-vote report, there will be attempts by the other side to dismiss its significance. Do you think they have a leg to stand on?

Mr. Andal: No. The question is, really, does getting a majority vote, which is less than a two-thirds vote, cause the report to be taken seriously? Because this is advice to Congress, the judge of the value of that advice will be Congress. Let me provide the following pieces of evidence that it already is being taken seriously. Before we even voted at our final meeting, we got letters from the Senate Majority Leader, Trent Lott, the Speaker of the House, Denny Hastard, and the House Majority Leader, Dick Armey. They all said they would like to have a majority report. Congress is looking for advice and that is why they put us into business. I think they realize that the reason we weren't able to achieve a two-thirds vote was because the three Clinton administration appointees refused to participate for all of the 18 months we were in business. And so it made it very difficult to achieve that mark. Leaders of the House and Senate have already told us that they want it, so already you have some evidence that they do take

it seriously. The second piece of evidence is some of the proposal that I worked on, the nexus proposal, which was adopted in the final report, is going to be introduced in the Senate by prominent authors. That is pretty good evidence that they took it seriously. And then the excise tax which is in that report was adopted by a majority vote. Al Gore has said he is for that; Richard Gephardt has said he supports it as well. In fact, all the leaders I previously mentioned have said they are for that, so the answer is that old saw is pretty much solved. The report has had real traction even in the two weeks it has been since Dallas; people are already using it. So there is de facto evidence that Congress is taking it very seriously.

Cal-Tax: What have you learned from this ACEC experience?

Mr. Andal: It was an extraordinary experience for someone like me who really enjoys the arena of ideas and policy issues and especially tax policy. This is a cutting-edge issue, probably the most future-looking tax policy question that we have on the table in the national debate. It was a national debate. Three governors were on our commission; six corporate CEOs were on the commission. I learned a lot from it and this is what public service is all about. Almost everybody who runs for public offices hopes to get a chance to be involved in this kind of debate over ideas, so I have really benefitted a lot from it.